It may feel like longer to some, but it was just a decade ago that a catastrophic housing crisis destroyed the lives of many Americans, with effects that still exist today.
As we approach the 10-year anniversary of Lehman Brothers’ collapse and the Great Recession, we should take a look back at the subprime mortgage crisis. How did it start and who was to blame? What happened, and what is still happening in the wake of it? And what even makes a mortgage subprime?
What Is a Subprime Mortgage?
Subprime mortgages are named for the borrowers that the mortgages are given to. If the prime rate for a mortgage is what is offered to people with good credit and a history of dependability, subprime is for those who have struggled to meet those standards.
People who are approved of subprime mortgages historically have low credit scores and problems with debt. There is no exact established number, but a FICO score below 640 is generally seen as subprime for a loan like a mortgage.
People with spotty credit histories like this often have tremendous difficulty getting approval on a mortgage, and as such the monthly payments have much higher interest rates than normal since the lenders view the loan as much riskier.
How Did the Subprime Mortgage Crisis Start?
How did the U.S. economy get to a point where in 2007, a full-on housing crisis began?
It doesn’t happen overnight. In the early-to-mid 2000s, interest rates on house payments were actually quite low. In what looked to be a solid economy after a brief early 2000s recession, more and more people with struggling credit were able to qualify for subprime mortgages with manageable rates, and happily acted on that.
This sudden increase in subprime mortgages was due in part to the Federal Reserve’s decision to significantly lower the Federal funds rate to spur growth. People who couldn’t afford homes or get approved for loans were suddenly qualifying for subprime loans and choosing to buy, and American home ownership rose exponentially.
Real estate purchases rose not only for subprime borrowers, but for well-off Americans as well. As prices rose and people expected a continuation of that, investors who got burned by the dot com bubble of the early 2000s and needed a replacement in their portfolio started investing in real estate.
Housing prices were rising rapidly, and the number of subprime mortgages given out was rising even more. By 2005, some began to fear that this was a housing bubble. From 2004-2006, the Federal Reserve raised the interest rate over a dozen times in an attempt to slow this down and avoid serious inflation. By the end of 2004, the interest rate was 2.25%; by mid-2006 it was 5.25%.
This was unable to stop the inevitable. The bubble burst. 2005 and 2006 see the housing market crash back down to earth. Subprime mortgage lenders begin laying thousands of employees off, if not filing for bankruptcy…